Member Trustee news Winter 2011-2012

• Welcome to the Winter edition
• Executive pay - an issue for investors
• Conference report
• Regulator statements on defined contribution (DC) and hybrid schemes
• Consumer Price Index: legal challenge fails
• Pensions Act 2011
• DC: The problem of small pots
• Responsible investment briefs
• FRC encourages trustees to question their actuaries
• TUC Fund manager voting survey 2011

Welcome to the Winter edition

Welcome to the winter edition of TUC member trustee news. As always, there have been plenty of developments over the last three months, including a new Pensions Act, three key statements from the Pensions Regulator, the outcome of the legal challenge on CPI, and much activity around the public sector pension campaign. And of course the TUC's trustee network conference took place in November with over 100 attendees; you can find further reports inside.

I would particularly like to draw your attention to the back page article on new guidance from the FRC. The work of the Financial Reporting Council is perhaps less well known to trustees than it should be, given that it is the regulatory and standard setting body for actuaries, though trustees will be becoming aware of the TAS (Technical Actuarial Standard) requirements. The FRC also wants to encourage users of actuarial services to understand what standards they can expect and has published a set of questions to help trustees.

Finally, all good wishes for 2012, which will no doubt be another 'interesting' year for all of us involved in workplace pensions.
Fiona Draper

Executive pay - an issue for investors

A number of recent reports on executive pay have drawn unfavourable comment from pensions and union organisations. Commenting on the Incomes Data Services report published in October, showing that FTSE 100 executives' pay rose by 49 per cent last year, Catherine Howarth of FairPensions said: 'Executive pay is still rising out of all proportion to shareholder returns and shop floor wages. This calls into question why FTSE 100 executive remuneration packages still receive overwhelming support from the institutional investors taking care of our pensions and savings.

These investors must now call time on excessive remuneration.'Commenting on the same report, TUC General Secretary Brendan Barber said: 'With the FTSE 100 down on last year and most staff getting pay rises of less than two per cent, these bumper settlements prove that CEO pay bears no resemblance to performance or economic reality.' Subsequently the report of the High Pay Commission Cheques with Balances: Why tackling high pay is in the national interest, set out a 12-point plan to halt 'spiralling' high pay. Responding to the report, NAPF chief executive.

Joanne Segars said pension funds have long urged restraint in setting directors' pay, and that there should be no reward for failure in the way remuneration packages are set. 'Complex bonus structures and the lack of transparency around executive pay are key parts of the problem.'

Meanwhile, the TUC's response to the BIS discussion paper on executive pay was highly critical of the role of shareholders: while 'a tougher approach on the part of UK investors could have an impact on remuneration practices via engagement ... we note again, that under the current system it is shareholders and shareholders alone who have the tools to influence executive pay. This system has in its own terms spectacularly failed. Without a new approach on the part of shareholders, any further measures that depend on their engagement or votes are likely to have little practical effect.'

Both the TUC and UKSIF used their responses to the government consultation on company reporting to argue that companies should disclose pay ratios in their annual reports. Penny Shepherd of UKSIF said: 'The pay multiplier for senior executives compared with the average employee can affect productivity as well as reputation. This can therefore be a valuable metric for investors assessing company performance within industry sectors.' The TUC noted that 'the ratio between the average pay of executives and ordinary workers has grown from 16 to 63 over the last 30 years. This growing pay gap is a problem for companies, their shareholders, their workforce and society more broadly ... there is clear academic evidence that high wage disparities within companies harm productivity and company performance. This is an issue that shareholders and Government should take extremely seriously. The TUC therefore supports the proposal that the ratio between the pay of the company's Chief Executive and the median earnings of the organisation's workforce should be disclosed. The TUC believes that top to bottom pay ratios should also be reported. Low pay should be a major concern to shareholders and also the wider public, as it tends to be correlated with lower productivity and motivation, lower levels of training, higher levels of staff turnover, sickness and other costs.'

Conference report

Those attending the Trustee Network conference 'People and Profits: Challenges for Trustees' on 15 November heard keynote speakers Pensions Minister Steve Webb, Dr. Paul Woolley from the London School of Economics and TUC Assistant General Secretary Kay Carberry.

Jess Hurd/reportdigital.co.uk

The minister paid tribute to the work of trustees, and went on to speak on a number of issues of concern, particularly malpractice in the use of enhanced transfer values (ETVs) to persuade members to transfer benefits out of DB schemes.

Whilst he did not wish to ban ETVs altogether, since they were sometimes to members' benefit, the DWP had established a working group to look at a code of practice and the need for actuarial standards in this area. In the meantime, the Regulator's guidance highlighted some of the issues trustees should consider. Other issues of concern to the minister included unfair charges for DC members, particularly for deferred members, and the possibility of regulation - or deregulation - to encourage employers to offer something better than pure DC arrangements. The minister also responded to a wide range of questions from attendees, on subjects including indexation, changes to contracting out, and the need to regulate annuity providers.

Other speakers included Ivan Walker of Thompsons, Christine Berry of FairPensions and Will Oulton of Mercer speaking in a panel session on fiduciary duty; all three emphasised that fiduciary duty was much broader than seeking to maximize short-term returns, and their talk was followed by a lively debate on the practicalities of responsible investing. The final keynote speaker of the day, Dr Paul Woolley, gave an extremely challenging talk on the flaws in academic investment theory and the costs to pension schemes of excessive share trading, which, in his view, led to excessive profits for the industry and disappointing returns for investors (see also new research on trading costs).

Attendees could also choose from a wide range of workshop topics, including responsible investing in emerging markets; the Investment Governance Group principles for DC schemes; automatic enrolment and workplace pension reforms; liability-driven investing; and investing in infrastructure.

As always, attendees found the conference very useful, bringing a distinctly different perspective on many issues from that of other trustee training events.

Next year's conference is provisionally scheduled for 27 November.

Regulator statements on defined contribution (DC) and hybrid schemes

The Pensions Regulator has published two recent statements for trustees of DC and hybrid schemes.

The guidance for trustees of hybrid schemes (i.e. schemes with DB and DC arrangements, including those with separate DB and DC sections as well as schemes which provide top-up or underpin arrangements) follows on from a survey of 150 hybrid schemes. The research found that trustees did not always understand their scheme structure. It also found that in 50 per cent of schemes surveyed, DB and DC assets were mixed together in the same bank account or investment fund, and in some cases were not separately identifiable.

The Regulator's statement includes a series of checklists which summarise the actions which trustees, administrators and others should take to make sure they are able to properly manage their scheme.

The statement identifies five main areas of concern, as highlighted by the Regulator's research:

• lack of governance: trustees may not be spending sufficient time on the DC aspects of their hybrid schemes
• unclear or incorrect member communications
• incorrect benefits or funding levels: where DB and DC assets are held together, e.g. in the same bank account or investment fund, member benefits may be incorrectly calculated
• inappropriate investment strategies: a third of the trustees surveyed said that their schemes used similar investment strategies for the DB and DC sections; this could be inappropriate, given that DC members typically carry the investment risk
• retirement options: almost a quarter of the schemes surveyed did not provide an open market option.

A separate statement for trustees of DC arrangements goes into more detail on the Regulator's expectations of trustees of DC arrangements - and in particular reminding them that these duties include deferred members. Executive director June Mulroy said: 'In DC schemes it is members that bear the risk. If a scheme is poorly run it can directly impact the value of a member's pension pot. Therefore it is vital that trustees have a firm grasp of the key issues for DC schemes that will assist members in receiving a good outcome from their savings - such as investment choices, costs and charges and decisions around converting pension pots into a retirement income.'

The Regulator highlights a number of issues, stating for example that trustees:

• need to have sufficient skills to manage the DC scheme effectively; they must also formally assess the capabilities of the trustee board (and manage knowledge gaps appropriately)
• should understand how charging structures work and ensure that they are applied fairly to all parts of the membership; the Regulator thinks that the practice of imposing higher charges for deferred members is unacceptable
• must, formally and regularly, review the range and appropriateness of the investment funds available and ensure that the default fund complies with guidance issued by the DWP earlier in 2011
• should understand the protection available under the Financial Services Compensation Scheme and carefully consider situations where compensation is not available
• must be able to demonstrate that they have assessed the key risks and documented them in a risk register
• must ensure that members are aware of the effect that contribution patterns will have on the overall size of their pension funds and should confirm that contribution processes and controls are ready to respond to the increased demands arising from auto-enrolment.

The Regulator has also set out six principles for good design and governance of workplace DC pension provision, which will form the basis of its regulatory approach going forward; these will be covered in more detail in the next edition.

Consumer Price Index: legal challenge fails

Following the Chancellor's announcement in June 2010 that CPI, rather than RPI, would be used as the basis for the annual indexation of benefits and public service pensions, several trade unions challenged the legality of the government's decision. They argued that:

• the CPI is not a proper measure of 'the general level of prices obtaining in Great Britain' (essentially because it takes into account changes in consumer behaviour in response to price increases)
• the government, in making its decision, had regard to irrelevant considerations or an improper purpose, i.e. the cost savings that could be made
• representations made over the years to members of the public sector pension schemes had established a legitimate expectation that RPI would continue to be used for up-rating purposes, but the government neither took those expectations into account nor consulted with the trade unions before making its decision
• the government failed to meet its statutory duty concerning the promotion of sex equality.

The Court unanimously rejected the first, third and fourth arguments. Two of the three judges also turned down the second argument. It was therefore held that the decision to use CPI for increases to public sector pensions was lawful. In the Court's judgment: 'There was never any promise or assurance given, or any practice adopted amounting to any such promise or assurance, which was 'clear, unambiguous and devoid of relevant qualification' that RPI would be the index of review in perpetuity.' For two of the three High Court judges, once the

Secretary of State satisfied himself that the CPI was an appropriate measure for determining changes in the general level of prices, it was open to him to adopt it even if his reason for preferring it is that it 'draws less on the public purse'. Even if he was wrong to have regard to economic considerations when deciding which index to adopt, they were satisfied that he would have chosen the CPI in any event.

The other judge thought that it was impermissible to use public expenditure considerations as the primary reason for choosing one index over the other, and agreed that the Government had 'put the economic cart before the statutory horse'.

Disappointing

Commenting on the outcome of the judicial review, TUC General Brendan Barber said: "This is a disappointing judgement for pensioners and scheme members whether they draw a private, public or state second pension. But we take great heart that the court accepted the argument that the government did this to cut the deficit rather than carry out a proper consideration of the best way of measuring the cost of living for pensioners, even if only one judge said that it was unlawful.' Grounds for appeal are being considered.

Meanwhile, a new paper from the Office for Budget Responsibility (OBR) suggests that the long-run difference between RPI and CPI may be significantly higher in the future than has been historically observed. The suggestion that in future over the long-run annual CPI is between 1.3 per cent and 1.5 per cent less than RPI inflation would, if borne out, have far-reaching consequences for pension scheme funding and member pensions.

Pensions Act 2011

The Pensions Act 2011, which received Royal Assent on 3 November, deals with a number of matters including the following:

State Pension Age (SPA)

The Act adjusts the equalization timetable for the SPA so that it reaches 65 for women in November 2018 and then rises to age 66 in October 2020 (affecting men and women born after 5 December 1954). Subsequently, the government used the Autumn Statement to propose bringing forward to 2026/2028 the increase of the SPA to age 67.

Auto-enrolment

A number of changes were made to the technical detail on the auto-enrolment requirements, many of which implement the recommendations from last year's review. Employers with money purchase schemes will be able to use them for auto-enrolment if they have certified that an 'alternative requirement' is satisfied: certification will allow for alternative contribution structures that are nevertheless likely to result in actual contributions being paid that are at least equal to the statutory minimum. The Act also allows the government to cap the charges payable by both active and deferred members of schemes used for auto-enrolment. (Subsequently the government announced a one-year delay to auto-enrolment for employers with fewer than 50 employees.)

Money purchase benefits

Following the government's defeat in the Bridge case, a new statutory definition of 'money purchase benefits' was added to the Act during its final stages so that a benefit will only be treated as money purchase if 'its rate or amount is calculated solely by reference to assets which (because of the nature of the calculation) must necessarily suffice for the purposes of its provision to or in respect of the member'. A pension in payment will only be a money purchase benefit if the benefit was 'money purchase' (under the new definition) before it came into payment and it is now backed by an annuity contract or insurance policy held by the trustees. Certain benefits that might previously have been regarded as money purchase will therefore no longer meet the definition: for example, pensions in payment that are not backed by annuities and benefits calculated using guaranteed investment returns. The amendment will have retrospective effect from 1 January 1997; however, it has yet to be brought into force. The DWP has said its application will be modified by secondary legislation, and that it will shortly publish a consultation paper containing draft regulations designed to achieve that purpose.

Revaluation and indexation

The Act will remove references to the Retail Prices Index (RPI) from the legislation governing revaluation and indexation. Broadly speaking, it will in future be possible to comply with the legal requirements by making increases that are (i) in accordance with the official Order published annually by the DWP, and now based on the September Consumer Prices Index, or (ii) determined by measuring CPI increases using a different reference period that is specified in the scheme rules, or (iii) based on an RPI-increase measure specified in the scheme rules.

Payment of surplus to employer

Section 251 of the Pensions Act 2004, which requires that trustees pass resolutions in order to preserve the effect of scheme rules allowing payments to be made to employers, will be amended to clarify that it is only payments of surplus from ongoing schemes that are affected. Trustees will have until 6 April 2016 to make such a resolution. Three months' prior notice must be given to the employer and scheme members.

The provisions changing the SPA and regarding surplus payments have effect from 3 January 2012. The rest of the changes will be brought into force by Commencement Orders, which have not yet been made.

DC: The problem of small pots

The DWP launched a consultation in December on the problem of small DC pots that 'looks at how Government and the pensions community can work together to solve a key challenge facing the workplace pensions system: the proliferation of small pension pots. We anticipate that automatic enrolment and a highly mobile jobs market will lead to around 4.7 million additional small pension pots in our future pension system.' The paper suggests a number of ways to help people get the most out of their pension, and more easily transfer and keep track of their pension savings. The proposed approaches include:

• improving the current voluntary transfer arrangements, including encouraging members to consolidate their pension savings and reducing the cost of administering small pension pots
• automatically transferring small pension pots to one or more aggregator schemes (e.g. NEST), so that all small pension pots are stored in one place
• automatically transferring pension savings so they follow an individual from job to job (unless the individual opts out).

The DWP is keen to hear from trustees as well as from other interested parties; the consultation period runs until 23 March. You can find further details on the DWP website at www.dwp.gov.uk/consultations

The paper also announces the abolition of short service refunds for DC occupational schemes. The DWP say: 'These rules jeopardise pension savings for low to median earners and have no continuing role in an automatic enrolment world. Abolishing the rules will retain £70m-£130m in pension saving. We aim to abolish these rules at the earliest legislative opportunity and expect the rule change to happen as soon as 2014, provided we are able to implement an accompanying solution for small pot transfers at the same time.'

TUC response

Responding to the DWP announcement, TUC Head of Campaigns Nigel Stanley said:

'We welcome Steve Webb's determination to end short service refunds. Contributions paid by the employer into a worker's pension retirement pot should belong to the worker, not be subject to a grab back by their boss if they happen to leave.

'The government is right to link short-service refunds to a compre­hensive solution to the small pot issue. We will argue strongly in the consultation that the interests of the pension saver should be para­mount. That requires a default op­tion that can guarantee low charges and sensible default funds.'

Responsible investment briefs

According to research by Clear Path Analysis, reported in Pensions Age, environmental, social and governance (ESG) issues are becoming increasingly important investment considerations for 82 per cent of fund managers. The report highlights that ESG investing allows investors better to anticipate future legal actions and financial stress stemming from environmental catastrophes or social malpractices. This in turn can lead to long-term performance advantages for investors. However, despite this increase, the report also underlines that 43 per cent of investors still remain unclear about the links between ESG and profits in the short to medium term.

In another Pensions Age report, research from SCM Private based on data taken from 1,287 UK individual pension funds found that 'excessive' and 'frenetic' trading by pension fund managers is generating £3.1bn in unnecessary annual costs that are not being disclosed to many investors. The research found that there was an average portfolio turnover of 128 per cent per annum, meaning that a typical holding is kept for just nine months before being sold. Such levels of trading can result in a number of increased costs such as buy and sell spreads, taxes, and commissions, which for a pension fund can add 0.7 per cent in costs per year. There are currently no regulatory requirements for fund managers to reveal the costs of their trading to investors.

FRC encourages trustees to question their actuaries

The Financial Reporting Council (FRC) which, amongst other duties, has responsibility for the regulation and standard-setting body for actuaries has issued a set of questions to encourage trustees to discuss the scheme funding process in greater detail with their scheme actuary.

The FRC says: 'It is important that trustees understand the actuarial advice they are given and provide challenge to the scheme actuary providing that advice.' The questions they suggest 'are intended to stimulate discussion and improve understanding of relevant issues, and thereby promote the quality of actuarial work.'

The questions suggested by the FRC, most of which are designed to be raised with your scheme actuary, include:

Does the valuation process start early enough so that there is sufficient time for data processing, calculation, negotiations with the sponsor and decision making?

How is the discount rate (used in calculating the technical provisions) derived? How does it compare with the rate used for other schemes? How does it compare with the rates of return from low risk assets such as government bonds?

How do the mortality assumptions relate to latest published statistics about mortality rates? Do the mortality assumptions make allowance for the specific nature of your pension scheme membership such as the occupation and location of members?

How are the other assumptions (rates of inflation, salary increases, scheme expenses, early retirements, etc.) chosen?

Are models in place to show how different future scenarios would affect the pension scheme?

Is a sensitivity analysis carried out for key actuarial assumptions?

How is your sponsor covenant assessed and how is it taken into account in making scheme funding decisions?

Does your actuary have other responsibilities which might affect their perceived objectivity, such as giving advice to both the trustees and the scheme sponsor?

How well does your actuary explain their advice? Does it reflect the specific requirements of your scheme's trust deed and rules?

How is your actuary's compliance with statutory requirements and professional standards monitored?

The full list of questions can be found at: www.frc.org.uk/press/pub2669.html

TUC Fund manager voting survey 2011

Remuneration reports drew the greatest opposition from institutional investors, according to the ninth annual TUC Fund Manager Voting Survey published in November 2011. The survey analyses the voting records of more than 20 fund managers, pension funds and voting agencies across 69 company resolutions during 2010. The survey has again found a sharp divide in voting stances, with four respondents supporting more than 70 per cent of resolutions, while five supported less than a third. Remuneration was the issue over which respondents were most likely to oppose company management. Surprisingly, however, given the banks' recent stock market performance and dividend return, bank remuneration reports comprised three of the five reports with the highest level of support in the survey.

This year's survey showed further progress in the disclosure of voting records, with 13 respondents disclosing a full voting record, compared to just nine last year. However, the quality of information varied, with several fund managers only disclosing votes against and abstentions, and others only providing headline statistics. Several respondents identified changes made as a result of the introduction of the Stewardship Code a year ago, such as improved engagement record keeping and revisions to conflicts of interest and stock-lending policies. However, it appears the Code has had very little effect on the voting stances taken by institutional investors.